The yield gap between junk bonds and U.S. Treasuries has narrowed, with the difference between Treasury yields and CCC-rated debt at 6.97 percentage points, the lowest since November 2007.
Additionally, the market is positioning on a dampened expectation for Federal Reserve interest rate hikes. Many traders are also betting that while the economy is just stumbling along, the market is unlikely to fall into a recession that would trigger widespread defaults.
According to Standard & Poor’s Ratings Service, default rates on low-rated corporate borrowers was 1.7% in April, slightly higher than the six-month low of 1.57% in march.
However, Kathleen Gaffney, portfolio manager at Eaton Vance, warned that junk debt investors could be stockpiling future risk, as rates have to rise eventually and pressure bond prices.
Investors, though, have been fleeing some longer duration high-yield bond exchange traded funds in favor of junk ETFs with less sensitivity to rising rates. The PIMCO 0-5 Year High Yield Corporate Bond (NYSEArca: HYS) has pulled more than $1.2 billion while the SPDR Barclays Short Term High Yield Bond ETF (NYSEArca: SJNK) has raked in over $1 billion this year. HYS has a 2.92% 30-day SEC yield and a 1.92 year effective duration. SJNK has a 3.8% 30-day SEC yield and a 2.16 year effective duration. [Short Duration Junk Bond ETFs in the Limelight]
For more information on the speculative-grade debt market, visit our junk bonds category.
Full disclosure: Tom Lydon’s clients own shares of JNK and HYG.